In choppy waters

When a stone-drunk lissome damsel stumbles and falls into your lap, depending on your orientation, you have three choices. One, you hurriedly eject her as damsels are just not your type, two, pass in favour of someone more participative or three, damn the consequences and make the most of it. Well, the promoters of Bharati Shipyard opted for choice number three when a vulnerable Great Offshore sauntered into their deckhouse. The resulting shipwreck is not only unsightly but painful to many. During the takeover frenzy that culminated in January 2010, Great Offshore’s market cap reached Rs 2,100 crore and Bharati topped out at Rs 950 crore. Now, Great Offshore is called GOL Offshore and like its first name, the market cap has shrunk to #272 crore, while Bharati’s market cap has sunk to Rs 140 crore. 

Let’s now hear what PC Kapoor (PK) and Vijay Kumar (VK), the promoters of Bharati Shipyard think about this carnage in shareholder wealth at Bharati and GOL. They believe it is incorrect to question the value addition created by the acquisition of GOL Offshore by looking at the current market cap. Says VK, “Valuing GOL only on the market cap parameter would be incorrect, as it is a temporary phenomenon and the situation will change once the market improves.” PK made our jaw drop even more when he said, “Market cap would come into the picture if we were planning to sell our shares, which we are not.” The promoters failed to mention that this decimation in shareholder value is an outcome of rising debt incurred to fund the acquisition and poor execution thereafter, which left Bharati with no option but to opt for a corporate debt restructuring (CDR) scheme. The state of affairs at GOL is not much better either, with the company having defaulted on its loans and delayed repayment to its FCCB holders.

"Market cap would come into the picture if we were planning to sell our shares, which we are not" - PC Kapoor, chairman, GOL and MD, Bharati Shipyard

Post the CDR, Bharati is trying to resurrect itself. But a CDR is no cakewalk: consortium lending has its own push, pulls and politics, so some banks may have agreed in principle, but may not release payments in time, thereby hindering smooth operations. Notwithstanding that, there is still a question on business viability. Ramesh Singhal, managing director, i-maritime Consultancy, the agency that had submitted the techno economic viability (TEV) report says, “The TEV was done when the financials were a little healthy. On today’s financials, we would have recommended something more stringent. In the report, we included a lot of caveats, the details of which I cannot share due to a NDA signed by us.” 

The problem, says another consultant is that typically banks ignore the fine print and endorse the base case given by an independent consultant. That means even if i-maritime may have highlighted that Bharati’s recovery is contingent on GOL’s ability to support its own orderbook, the banks may not have evaluated GOL’s financial strength. A fact that was admitted by SBI Caps itself. Supratim Sarkar, group head, project advisory & structured finance group, was livid when called up for details on the basis of which the CDR was approved. But amid the dressing-down he gave this writer for asking probing questions, he did say that Bharati’s assessment did not include GOL despite a common promoter. If there was a gaping diligence hole, this had to be it. 

Almost everybody associated with the company we spoke to for the story tried their best to stonewall us. Leading from the front, of course, was the Bharati management. Their response to Outlook Business queries resembled the work in progress at its yards — delayed, incomplete and unseaworthy but one that carried a questionable promise of future delivery. While on the face of it, the acquisition of GOL by Bharati may seem like bad timing, dive a little deeper and you get intrigue, opportunistic greed that backfired, a boatload of debt that may never get a safe harbour and a lot of investors who may never see any return on capital. 

 Yours is mine

For those who came in late, let’s start with intrigue. Until December 2008, the then 16-year association between the founders of Bharati and Vijay Sheth who ran Great Offshore (after it was demerged from Great Eastern Shipping) was a harmonious one. Sheth had pledged his holding to raise money to pay off his cousins to buy their holding in Great Offshore following the demerger. As the value of the pledged shares had eroded, the financiers were badgering Sheth for more collateral. The comfort Sheth had with Bharati prompted him to turn to PK and VK in his hour of need. And this is where things get hazy. 

It seems that while Sheth’s SOS was responded to, his life jacket was probably yanked before he could pull it on. Though they threw a credit line in November 2008, in early May 2009 PK and VK issued a repayment notice to Sheth. Since Sheth could not raise the money required in the “notice period of two days”, PK and VK invoked the pledge and bought 14.89% of Great Offshore and announced it was “a strategic long-term investment.” Before the ink had dried on the press release, rumours of an open offer started doing the rounds. Evidently, PK and VK’s intention of holding “a strategic long-term investment” had transformed into an unexplained desire for ownership. That Sheth was not in agreement with the actions of the Bharati promoters is evident when he resigned as managing director of Great Offshore just before the open offer. Vijay Sheth refused to come on record and tell us his side of the story. 

While it is still not clear to us as to what prompted the need for an open offer in May 2009, the explanation bandied around was that Sheth’s resigning amounted to a change in management. PK had then said, “The purpose of the open offer is to consolidate the investment in Great Offshore. This acquisition will provide enhanced stability to the existing management in Great Offshore and maximise shareholder value for both the companies.” Precisely what Bharati has failed to achieve. And the explanation for getting into a bidding war that ensued after ABG Shipyard jumped into the fray: “At that time 35% of the orderbook was with Great Offshore, what if it had gone to a competitor?” Well, the bidding war only happened after the status quo was disturbed; until then the Sheth-led Great Offshore was always on your side!

Opportunism aside, the acquisition came at a great cost to Bharati’s balance sheet. Not only did it overpay, it has not been able to reap the much talked-about synergies. The management’s contention was that being in the offshore industry GOL would help take care of the cyclicality in Bharati’s shipbuilding business. But that hasn’t happened. Tarun Agarwal, associate, i-maritime, says, “Acquisitions work well when there is a good handover from the people who are passing the baton. Companies are run by people and if they are not supportive of you, it cannot be successful.” That surely stands true for Bharati as, without Sheth, the new owners did not know how to run the offshore business. Blaming the current condition on recession then was the most convenient thing to do. Another mystifying fact is that even as Bharati was digesting GOL, it went ahead and bought Tebma Shipyards. 

"GOL's debts have increased on account of loans to subsidiaries to acquire the jack-up rig" - Vijay Kumar, managing director, Bharati Shipyard

Besides the acquisitions, Bharati also mistimed the expansion at its Dabhol and Mangalore yards. Not only was the Mangalore yard delayed, the resulting capex took its toll. The plan was to use the Dabhol yard to make jack-up rigs and move up the value chain. But given the management’s lack of expertise, the delivery of the jack-up rig was delayed and a result the customer (GOL) lost an ONGC order that could have fetched $250 million in revenue over five years. 

 Liquid rescue

The entire focus now is on turning around the ailing shipbuilder. The management’s turnaround plan involves completing the current orderbook, getting more defence orders and sweating the assets at GOL. VK says the company plans to complete its existing orderbook of 68 vessels in the next two and a half years. “We have indicated to our bankers that if these 68 vessels are delivered over the next two and a half years, debt would come down by Rs 1,500-2,000 crore.” How realistic is that, given the company’s execution history? The highest number of vessels delivered in the company’s history was in FY09 — and that is eight. 

That track record looks worse when you consider the company’s accounting policy. Its annual report states, “The company books subsidy when the vessels are nearing completion i.e. when the vessel is more than 70% complete.” In FY11, Bharati booked a subsidy income of Rs 210.78 crore and delivered five vessels. Then for FY12, the company booked subsidy income of Rs 294.41 crore and delivered four vessels. If indeed many vessels had crossed the completion stage in FY11 and FY12, those deliveries should have reflected in FY13. Instead, the turnover for the nine months of FY13 collapsed 60% from Rs 979.56 crore to Rs 399.96 crore. Part of the explanation could be that work at yards has stopped due to slow disbursement of CDR funds, but what about the work that had reached more than 70% stage and where subsidy was booked? At least the remainder revenue for the final stage should have shown up. PK and VK cannot even blame interests costs for the net loss of #373 crore — interest cost for the period under consideration is Rs 320 crore compared with Rs 331 crore last year. At this pace it will not be surprising if Bharati ends up delivering only three or four vessels in FY13. 

Then again, while defence orders are seen as a key driver of revenues, the management itself says, “Orders from defence has come in the last couple of years only and value-wise it comprises only a little above 10%.” But with every shipbuilder eyeing that segment, defence orders may get you bread but not much butter or jam. As for business from other Indian offshore players, it’s only getting tougher. Uncertain execution at Indian shipyards has meant that Great Eastern Shipping and its offshore arm Great Ship source vessels from the best yards worldwide. Anjali Kumar, deputy general manager, corporate finance, Great Eastern Shipping, says, “We have one or two vessels built in India but our experience with Indian shipyards has not been very happy. Exploration by its nature is a highly technical business and we do not like to take a technical risk by giving it to a new or smaller yard.”

 Loose lips sink ships

With worsening business, governance is taking a backseat. In FY13, both Bharati and GOL saw a change in auditors. Statutory auditor Kalyaniwalla & Mistry (K&M) resigned from GOL and Bhuta Shah & Co resigned as joint auditor from Bharati. While the management explains the change as “good corporate governance practice in line with the new Companies Bill,” their version differs from what was stated in the annual report. The development at K&M was strange because the firm seems to have changed its mind in three months about continuing. In May 2012 it communicated its availability and in August 2012, it expressed its “unwillingness to continue.” This point raised by us about the “unwillingness on part of the auditor” was conveniently sidestepped by the management. 

Vinayak Padwal, auditor at K&M when contacted said, “Unwillingness is generally an outcome of either a client taking excessively risky business measures or it becoming uncooperative during audits or the account turning non-remunerative.” When pressed further for details on why his audit firm changed its mind in three months, Padwal clammed up citing ethical reasons. Mitesh Kothari, the auditor at Bhuta Shah & Co when asked about the disconnect between the management’s version and the auditor’s cited reason of pre-occupancy, said that despite the disconnect he stood by his firm’s version.

It seems, in a great display of pro-active governance, the management decided to change its auditors because they have completed five years. Incidentally DPH & Co, the statutory auditor at Bharati will complete five years in FY13. When asked if they will also replace DPH this year as a measure of good governance, the management had no answer. If Bharati continues with DPH in FY14, the intent behind change of auditors is clearly questionable. Ramesh Lakshman, chartered accountant and founder, RLCO says, “If the standard is not applied to all auditors in the group, then it questions the veracity of the claim that change is to meet standards of governance in advance. Any selective application is always a question mark.”  

Then, there is conflict of interest at play. For an offshore company, having your own yard is a double edge sword — you can get priority deliveries, but in lean times you are forced to build at your own yard. If that had not been the case you could have gone to the market to get the best price. How do PK & VK, who are members of acquisition/disposal of vessel & real estate committee at GOL, resolve this dilemma? Their obvious claim is an “arm’s length relationship” between Bharati and GOL. How then, do they deal with delivery delays — apart from the ONGC rig, another three ships of GOL have been delayed. But unlike clients like Clipper which are in litigation with Bharati, GOL has no such luck. 

 Leaking oil

On the contrary, GOL’s financial health has been compromised with a curious rise in loans and advances made to its overseas subsidiary. Usually, shipbuilders pass on cancelled orders to their subsidiaries because any cancellation due to execution delays means that the shipbuilder not only has to refund the advance, but also writeback the subsidy it has availed from the government for the same. Selling off the asset to overseas subsidiary then becomes a convenient escape route. Great Offshore (International) has received substantial loans from GOL. VK admits that GOL’s debts have increased primarily on account of loans and advances to subsidiaries for acquiring the jack-up rig. Asked that if the loans were made to be paid to Bharati, why is it being routed through a subsidiary, the company said a subsidiary structure was beneficial to access funds at a cheaper rate and better terms. If that is indeed true, why is the parent lending to it? Why is it not borrowing from the open market? Obviously the previous auditor, too, failed to see the point and had qualified the same in the GOL FY12 annual report.

Between a rock and a hard place - Graphic

What exactly transpired at GOL Offshore between the management and K&M is not clear, but there was constant qualification on the part of the auditor regarding GOL’s investment in its KEI-RSOS subsidiary as well as those relating to recognition of mark to market losses arising from derivative instruments like interest rate swaps. The auditor has maintained that the networth of KEI-RSOS has substantially eroded and cash flows are under stress. But the management continues to insist that all is well at KEI-RSOS and states no provision is necessary for the loans and advances of Rs 221.63 crore. In addition, GOL has provided a corporate guarantee of about #145.85 crore. Lakshman says auditors don’t just resign because they have qualified the accounts. “They might have resigned under pressure from the management who might have told them that they may propose other auditors. Most respectable auditors would not like to be defeated in a vote by management and, hence, submit their resignation.”

 Over and out

GOL has posted a standalone profit of Rs 70.84 crore for the first nine months of FY13. But even in the standalone topline of Rs 679 crore, Rs 82.27 crore came from the sale of ships. If this selling of new ships turns out to be a trend, then that development is worrisome as the average age of GOL’s fleet is much older than its most formidable competitor Great Ship. With its old fleet, GOL will find it hard to win business in international markets. India, of course, is a different market with the biggest player being ONGC. The state monolith controls about 75% of the market for offshore drilling and has some very questionable business practices.

For instance, when world over the best practice is not to hire vessels that are more than 15 years of age, it is only recently that ONGC fixed a maximum age of 27 years for offshore vessels. But how and why it narrowed down to 27 years is a mystery. Suffice to say that the hard to logically decipher policies of ONGC have kept several Indian offshore companies in business. Great Eastern’s Anjali Kumar says, “Differential tendering is only being applied to rigs and not to vessels. Thanks to that one business, many companies with older assets are flourishing. They get the same $10,000-12,000 that my modern vessel would get. So, to that extent, Great Ship is at a disadvantage.” Among the various offshore companies, Great Ship too counts ONGC as an important customer. “Our biggest strength is the age of our fleet and that we do not have an overleveraged balance sheet,” adds Anjali Kumar. 

The basic difference between Great Ship and GOL is that Great Ship has the flexibility to bid and win international business. It implies that going forward, GOL with its ageing fleet is not only at a disadvantage when bidding for international tenders, all its vessels that are more than 27 years old will find the going tough in ONGC’s new tenders. Given Bharati’s tardy execution, the only way out for GOL is to buy new vessels from the open market. Here, too, it is constrained due to its financial condition. Of course, the management thinks the liquidity problem is not going to last long. In fact they are confident that GOL, unlike Bharati, will not have to apply for a CDR. VK says, “GOL has over Rs 1,200 crore of unleveraged assets. Once these assets are delivered and/or deployed, GOL will not have liquidity issues.”

Despite the financial mess, what is discomforting — and also what seems to keep the two companies going — is that in everything they do, there is a government connection. Of the 59 ships in its orderbook, 32 belong to the Indian Navy and Coast Guard. Going forward, the management is banking heavily on new defence orders to improve its cash flows. VK says all the new orders for 10 ships worth Rs 760 crore that Bharati received in FY13 so far are from government clients. Even on the GOL side, the biggest buyer is state-owned ONGC. The lead banker for the Bharati CDR is SBI. Majority of the directors on the boards of both Bharati and GOL have either worked for public sector units or banks. Interestingly, even after all the institutional shareholders had fled Bharati by June 2010, the government’s investor of last resort, LIC, continues to stay invested in Bharati Shipyard, having rotated its holding through its various schemes. 

Of all its misgiving, the most grave governance lapse by the promoters arguably is their decision not to go ahead with a preferential allotment in January 2012 (the offer was to subscribe 1,552,700 convertible warrants at Rs 139 per warrant) stating financial stress, and then agreeing to subscribe to 3.2 crore preferential warrants at Rs 79.12 a share as part of the CDR. The participating banks have also subscribed to 2.88 crore compulsorily convertible debentures at Rs 79.12 amounting to Rs 228.35 crore. Incidentally, that infusion due in 18 months is more than Bharati’s current market cap. Post full warrant conversion, about 52-53% of the promoter holding in Bharati will be pledged, according to VK. The biggest holders outside the promoters now are LIC and the consortium of banks that is funding the CDR. 

In hindsight, the GOL acquisition looks opportunistic and not one that was well calculated and thought through. Do the promoters look back and think perhaps things should have been done differently? VK says, “I don’t think we have any regrets. GOL was about 33% of the Bharati orderbook when they operated as independent companies; today GOL’s share of the current orderbook is only a little below 50%. This itself is ample proof that GOL has contributed substantially to Bharati.” It’s here that the story of the golden goose comes to mind. Instead of being content with getting one GOLden egg a day, PK and VK chose to have it all at once.